Malawi - Rural Financial Services Project

Document of The World Bank FOR OFCLAL USE ONLY Ropwt No. P-5968-MA M PIANDWI AND RECONMEDATION OF THE PRESIDET OF THE INTRTIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS 0N A PROPOSED CREDIT OF SDR 18.0 MILLION (US$25.0 MILLION EQUIJVALENT) TO THE REPUBLIC OF MALAWI FOR A RURAL FIACIAL SERVICES PROJECT MAY 4, 1993 MICROFICHE COPY Report No. :P- 5968 MAI Type: (PM) Title: RURAL FINANCIAL SERVICES PROJE Author: OKIDEGBE, N Ext. :37566 Room:J11145 Dept.:AF6AG This document has a restricted distribution and may be used by recipients only in the perfornmance of heir official duties. Its contents may not othenvise be disclosed without World Bank authorization. I  CURRENCY EQUIVALENTS Currency Unt = Malawi Kwacha (MK) US$1 = MK 4.0 MKI = US$0.25 ABBREVIATIONS DEM[AT = Development of Malawi Traders Trust EC European Community EEC = European Economic Community FSEDP = Financial Sector and Enterprise Development Project GOM = Govrnment of Malawi GTZ = Deutsche Gesellschaft Fur Technische Zusammenarbeit GmBH IDA = hntational Development Association PAD = International Fund for Agricultural Development MMF = Malawi Mudzi Fund MRFC Malawi Rural Finance Company MOA = Ministry of Agriculture NDF = Nordic Development Fund NRDP = National Rural Development Program ODA = Ovseas DevelopmentAdministation RBM Reserve Bank of Malawi RFSP = Rural Financial Services Project SACA = Smallholder Agricultural Credit Administration USAID = United States Agency for Interational Development UNDP = United Nations Development Program FISCAL YEAR Government * April 1 - March 31  FOR OMCL4 USE ONLY MLAWI RURAL FINANCIAL SERVICES ]PROJECT Credit and Project Sumniary Borrower: Republic of Malawi Beneficiaries: 500,000 rural households, small estates, micro-, small- and medium-scale enterprises and Malawi Rural Finance Company. Amount: SDR 18.0 million (US$25.0 million equivalent) Terms: Standard IDA terms, with 40 years maturity Onlending Terms: Reseve Bank of Malawi (RBM) would onlend US$17.0 million equivalent of IDA Credit to Malawi Rural Finance Company (MRFC) in local currency at the prevailing average cost of term borrowing in the financial system or the discount rate whichever is higher. MRFC would onlend the finds at market rates for financing viable farm and non-farm rura activites. RBM would pass on to the Govenment the interest received from MRFC, less a 0.5 perntage point fee to cover RBM's administrative costs. The Government would bear the foreign exhange risk. The Govenment would provide US$8.0 million equivalent as equity for institional building of the Malawi Rural Finance Company. Financing Plan: Project Financing Plan Local Foreign Total - US$ million 11DA 11.9 13.1 25.0 Government 4.0 - 4.0 MRFC 4.7 ' 4.7 Sub-borrowers 3.0 - 3.0 Total 23.6 13.1 36.7 Rate of Return: Not Applicable Staff Apprais Report: No.1 1464-MAI Map: IBRD No:20924R This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCUITION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDlT TO THE REPUBLIC OF MALAWI FOR A RURAL FINANCIAL SERVICES PROJECr 1. The following memorandum and recommendation on a proposed Credit to the Republic of Malawi for SDR 18.0 million (US$25.0 million equivalent) are submitted for your approval. The proposed Credit would be repayable over 40 years, indcuding a grace period of ten years at sdard IDA terms. It would help finance a program to imprisve the access to financial services for the rural sctr and increase competition In the financial system of Malawi. 2. Backgrdund. Despite a series of adjustment programs, Malawi remains one of the poorest countries in the world with a per capka GNP of US$210 (1992). Malawi is extremely vulnerable to external shocks because of its geographically land-locked posiion and narrow resource base. Although the county has made coi,siderable progress on the macroeconomic front over the past four years, the medium-term economic outlook is highly uncetain because of: the extnal shocks and the adverse impact of an unprecedented dwught in 1992 throughout Southern Africa; and 3 deteriorating relations with bilateral donors due to unresolved iswes reated to governance. 3. Malawi's development strategy following Independence in 1964 emphasized infrastructure and agrclture as vehicles for increased production. While the estate sub-sector was deemed to be the diving force for export growth, producer prices in the smallholder sub-setor were kept below world market levels to transfer resources from the smallholder sector into the estate and agro-processing sub-sectors. The county succesflly exploited its endowment during the 1960s and 1970s when real GDP more thn doubled and real per capita income grew by 3 percent per year. ITe period of strong eonomic growth came to a halt in the early 1980s when the county faced a combination of unfvorable tems of trade, high interest rates, weatherrelated shocks, and other major domesi policy weakneses. The first series of adjustment operations was a response to this set of shocks. However, while the Government of Malawi (GOM) was adjustig to these shocks, the country was hit in the mid-1980s by a worsening of the war and civil strife in neighboring Mozambique which not only led to a major increase in inteational transporation cost but also to increased security-reted expendiures and a large influx of refugees. ihis cawd shap deterioration in the m c environment in the mid-1980s. With the partial reopening of the Nacala rail route to M ique in October 1989, and the recent peace ageement, the Moambique siuation is Improving but remains very unceain Certain policy responses to this second and more dramatic set of shocks, including expanded fiscal deficits and implementation of import controls, compounded the difficulties and discouraged private sector investments and outpu. 4. In 1992, the economy was affected by two major shocks. The wvere drought of 1992 sharply reduced the maize crop by nearly 60 percent. Widespread poverty and food iserity merged as important soci dimensions to the economic difficulties. This has resulted in additional foreign xchange requirements of US$236 million for maize imports in order to avoid widespread food shortages, malnutition and strvato In addition, drought-related expendiu for Intenal distribution of emergency food aid, water supply rehabilitaion, and health programs have furher worsened the Government's fiscal difficulties. Furthemore, at the May 1992 Consutative Group  -2 - (CG), bilateral donors and the European Community (EC) refained from pledging additional ternal assistance to Malawi mainly becuse of reasons related to political governance. To close the resuldng fiscal and extal fiancing gap, the Malawian autorities implemented an austerity packae in June 1992, comprising - inter alia - 22 percent devaluation of the Kwadha, strict expendure controls and additional tghtening of the monetary policy. These measures have helped the economy to remain broadly on track. Nevertheless, dmely resumption of bilateral and EC exten support, e.g. balance of payments support, is crucial for the successful continuation of the adjustment program. 5. The Government's objectives for the rura economy, of which agriculture and agriculture- related activities form the most important part, are to promote economic growth, raise nrur Incomes, ensure food security, and increase export earnings while conserving natural resources. Specifically, as indicated in the Statement of Develkpment Policies (1987-96), the rural sector objectives are to improve the economic and social conditions of the rural commities through productive self-help programu which would enable them to contribute filly to national economic development. These objectives are being pursued through programs undertaken wih support from IDA and several donor agencies (IFAD, UNDP, USAID, NDF,GTZ, ODA, and EEC) with emphasis on: (a) promoting private sector involvement in viable rural activites; (b) providing inives through liberalizing the pricing and marketing system, and increasing producer prices of export crops; and (c) rehabilitating rural infrsructre, and providing support services (research, extension, and input supply). 6. Although several government programs have been put in place to develop the rural sector, the productivity of smallholders is still constrained to a great eten by limited access to fiancial services. The National Rural Development Program (NRDP) was established as the main vehicle for providig institutional credit to smallholders. Under NRDP, the coury was divided into eight Agricultr Development Divisions (ADDs), each supported through a line of credit by different donors. In 1988, with the assistance of IDA and IFAD, the Governmt consolidated all the credi programs under the SmalMholder Agricultural Credit niion (SACA), a department wihin the Ministy of Agriculture (MOA). SACA, like NRDP before it, chnneled credk to smaliholders through groups (Farmers Clubs) and achieved high recovery rates, averaging over 90 percent In the 1991/92 season, SACA disbursed approxnimately MK 80 million to about 330,000 beneficiaries (of whom 93,500 were women), represting about 23 percent of rura households. Other financial institutions dta serve the rural sector, such as Small Enterprise Development Organization of Malawi (SEDOM), Malawi Union of Savings and Credit Cooperatives Ltd (MUSCCO), and Malawi Mudzi Fund (MMF), which are also set up to provide credit primariy to microentprises not served by the commercial banks, are less successful in achieving their objectives despite their high cost of operations. Several steps are being taken to remedy their management deficiencies. It is recognized, however, that improvemens in their performance would be slow to matialze, and their impact in rural areas would be modest in view of their scale of operations. 7. In connection with the preparation of the proposed Project, an in-depth review of the fnancial services currently available to te rural sector was undertake. The data from this review show dtat limted access to financial services remains one of the man impediments to sustained economic growth In the rural sector. There are newly developed high yielding technologies available for maize production, which have the potial to double the estimated daily return to labor of smallholders, but the access to credit is an important prerequisite for the adoption of these innovations by a critical mass of smalilolders. The fiancial instiutions (both formal and informal) dth serve tbe rral sector do not provide adequat services, and are not easily accessible to large segments of smallholder hfmers and microenterprises. The IDA-financed Financia Sector and Enterprise Developme Project (FSEDP) is providing the fiamework for reformig the financia sector. However, as  - 3 - Indicated in the Malawi Finamcial Sector Report, the liberalization and deepenig of the fiancial system is recognized as a long-term goal. Experience from other countries shows that following liberaization of the financl sector, commercial banks are generally not likely to increase lending to agriculte or small-scale rural enterprises becs transaction costs and risks are higher ta in other sectors. Furthermore, the two commercial bank in Malawi lack the infstrcture, instrument, experience and managerial capacity to mobilize ura savmg and channel adequate resources to viable rral enterprises. Besides, there is no effective competition in the banking system, hence the commercial ban have no incentive to build infrastructure, develop expertise, or cultivate with innovative techniques for lending to the rural sector. In the short to medium term, therefore, the financial needs of the rural sector, particularly of the emerging rural enterprises, are not likely to be met through the existg channels in thei prese state. S. The data from a review of Ma-ai's rur finance sector carried out by IDA in 1992 show that limited access to fiancial services remains one of the man constraints threatening sustained economic growth in the rural sector. This review also concluded that SACA, the Governmentms main vehicle for channelling credit to the rural sector, as cuently constituted could not be sustainable, given high subsidization (about MK 4.0 million per year and rising) and heavy involvement of ension staff in the provisions and recovery credit. In addition, SACA is currently serving only twenty-three percent of Malawi's rural households, with litde prospect of either expanding the coverage or developing new and more suitable instuments for lending to the rural sector, becase the management of SACA is stifled by overt goverment involvement. When NRDP was consolidated into SACA in 1988, it was anticipated that SACA would evolve into a fill service bank. According to the review, there is a very strong case for privatizing and converting SACA into a rural bank, capable of serving wider segment of the rural populaton, including developing new and appropriate instuments for lending to the rural sector. Given the present stage of Malawi's financi sector development and the limited competition within the banking system, converting SACA Into a bank is compelling. Transformation of SACA into a viable fianci institution will, nonetheless, have to proceed in a phased manner to ensure meaningful private sector participation. 9. Project Objectves. The Project's fundamental objective is to improve the access to financia services for the rural sector, incluiding women, on a sustanable basis. The immediat objective of the Project is to lay the foundaion for sustainability of rural financial services by corporatizing and converting SACA into an autonomous company and preparing it for privadzation and transformat into a private rural bank. 10. PIroject Descripton. Ihe Project would be implemented over a three year priod and has three main componens: (1) axfasx kwbadding component (US$16.7 million or 45 percen of total Project costs) woud support (a) the corportzation and conversion of SACA into an auonomous lmited liability company (Malawi Rural Finance Company) which is the first phase of a two phased program of pnvatizing and transforming SACA Into a private rural bank; and (b) the use of Development of Malawi Traders Trust (DEMATr) to assist in prepaing investment proposas for agriculura and small- and micro- entprises and to provide training to rural enreprenus; (2) a kw of chditoonent (US$20.0 million or 55 percent of total Project costs) would finance primarily short-term loan requiremens of farm and non-farm rural activities; and (3) apilotprogram conponent would support initiatives to test innovaive approaches for providing financial services to women entrepreneurs engged in income-generating activities in the rural sector. 11. Project 1nadnag. The estmated total project cost would be US$36.7 million. IDA would fnance US$25.0 million (68 percent), of which US$8.0 million would be for instution building and  -4- US$17.0 million would be for the line of credit. The balance would be financed by Government - US$4.0 million (11 percent), MRPC - US$4.7 million (13 percent), and the remaining US$3.0 million (8 percent) would be conributed by the beneficiaries (smallholders, microentiprlss, etc.) in the form of equity contribution for sub-projects. lhe costs and financing plan for the Project are provided in Schedule A. Procurement and disbursement details are provided in Schedule B. The timetable of key processing events is provided in Schedule C. The status of Bank operations in Malawi and the staement of IFC investments are provided in Schedule D. 12. Project Implemenmton. All project components would be implemened by MRFC which, though newly established, would be staffed by a large number of the former SACA staff who are experienced in agriculural credit and are implementing an ongoing lIDA-financed project. Project implementation in Malawi in the past has suffered from weak institutional capacity and slow disbursement, particularly in the public sector. The implementation problem is caused by a shortage of experienced manpower, poor knowledge of Bank's disburement procedures and policies, and lack of counterpart fiuds. IDA has taken actions to alleviate the problem of slow disbursement by caying out disbursement workshops in Malawi and providing assistance to vaious government agencies in resolving disbursemen issues and clearing the backlog. However, this Project would be Implemented by private sector entitles, and given the safeguards buil intD the project design, this problem is not likely to adversely affect project implementation. 13. Project Sustainabllty. The MRFC would be an autonomous financial institution, operating on a commercial basis without government interference. The Project would conibute to deepening the rural financi system ud imWproving the accessibility of financial services to the rural sector by developing new instuments for lendig to viable rural activities, including farm and non-farm enterprises. The Project would have no inremea recurrent expenditure implications for the government budget. 14. Lesso Learned from Rural hiauce Opertons. IDA has supported several rural finance projects in Malawi. These projects indicate that group lending is an effective instument for providing credit to the rural sector, with high loan recovery rates (averaging over 90 percent), provided the groups are self-selected, cohesive and voluntary. Experience also shows ta a disort financial system, inadequate project design, weak isitional capacity, and unrealistic project scope adversely affect project perfonnance. These factors have been taken into consideration in the design of the proposed Project. The instional capacity would be strengthened, and the project design has beea kept simple. In additon, up-front actions would be taken before project approval. Bi-annual project reviews, including a mid-term review of project performance, would be und n at the end of the second year of the Project to address specia issues tat may arise during project implementaion and warant mid-course correcton. 15. Rationale for MDA Involvement and LAnka with Country Stategy. Support for the rural sector is an important element of IDA's assistae strate in Malawi, aimed at fostering economic growth, food security, poverty reduction, off-farm employment, and protectig the natural resource base. IDA has developed a two-pronged approach to assist the Govenment in its efforts to overcome the constaits fbcing the rura sector, namely the execution of finacial policy reforms, including incraing the accessibility of financial services, and the rehabilition and improvement of key agricultural sevices. IDA Credits designed to support the Government's sectoral policies (Agrcultural Sector Adjutme Program, Agricultural Research, Extension and Planning, and Fisheries Development Projects) are insumental in providing the environment for, and direct suppor to the development of ural enterprises. The proposed Rural Fianci Services Project would  complement the financial reforms under FSEDP to improve access to financial seices for dhie ru sector. It would finance expansion of agriculturd production and a4option of new and improved technologies, suppeot the development of rural commercial investments, and assist the expansion of vizole rural activities. More importantly, IDA involvement would help ensure the succesu corporatzation and conversion of SACA into an autonomous limited liability company, with commercial operating policies and procedures, which is the first step in the process of privatzing and transforming SACA into a full service rural bank. 16. Agreed Actions. Assurances on the following matters were obtained during negotiations: (a) MRFC would be a limited liability company and would be autonomous in policy, operational and management matters and function on a commercial basis; (b) Govenment woud embark on transformig MRFC into a rural bank under the Banking Act of 1989 with meaningful private sector participation within three years; (c) RBM would adopt acceptable mechanisms, t an d conditions of on-lendig to MRFC; (d) Goverment would send to IDA at least once a year an assessment of the impact of the Project on beneficiaries; and (e) MRFC would ensure duth investments financed under the Project would not have negative environmental impacts. The appointment of MRFC's General Manager and Financial Controller and the signing of the Subsidiary Loan Agreement betwhee the Government and MRFC are conditions of Credit Effectiveness. The conditions of disbursement for the Line of Credit Component are the finalization of MRPC organization structure, manuals and policies and procedures acceptable to IDA, and the transfer to MRFC of the activities, assets and liabiliies of SACA. 17. Environmental Aspects. Activities to be financed under the Project would be small in scale and pose no major environmenval issues. Under the Project, environmental guidelines would be provided to the MRFC aud investors. Where necessay, environmenta assessments would be caried out and subproject designs modified to include mitigaing measures. Annual lending programs would be reviewed by the Environmental Unit in the Department of Research and Eavironental Affairs, Office of the President and Cabinet. 18. Project Relevance to Program of Special Emphasis. The Project would have a favorable impact on key areas of special emphasis: (J) rural poverty alleviation would result ftom increased crop production and non-farm incomes earned from income genag acdvities; (ii) food security would improve with increased agriculurua production and non-farm incomes; (iii) improvement In the economic and social condition of women would result from supportig incomegeneratig activies, especially those tdat are owned and managed by women; and (iv) private sector developame would be facilitated through privatizing government credit activities by conveting SACA into an autonomous limited liability company, and by implementing the Project through private sector entities. 19. Project Benefits. Ihe proposed IDA Credit would support additional new investments by improving the availability and accessibility of credit to rural households for viable farm and non-faum activities. The number of households that would benefit from the Project would be expanded from 330,000 currently served by SACA to more than 500,000 rural households (an additional 170,000 households or 52 percent). The Project would, therefore, strengthen and expand the production base of the rural sector, increase employment and household Incomes. This would result in reducing rura poverty while enhancng and accerating the economic development of ural areas of Malawi. In financing smailholder agriculture and by releasing extension staff to undertake genune extension work, the Project would support measures necessary to obtain the required production response from agriculture that would help in increasing Malawi's export eanings, enhacing food security and  -6- nutritonal intake, and improving mral incomes and living sandards. The improved access to credit by micro-, smal- and medium-scale enterrises (MSMSEs) opeating in the rural areas will improve real sector supply response. The support for MSMSEs, including women entrepreus, is likely to gener higher levels of employmeat. Since the involvement of women in this Project is of primary importance, an Acdon Plan was developed for hcreasing the availability of credit to women. ITe effective monitoring of the Action Plan would alleviate one of the major constaints facing women entrepreneurs. 20. Projed Risks. The main risks would be: (i) possible economic slowdown which could reduce the capac& y of farmers to repay their loans, result in higher default rates, and undermine the viability of MRC; (ii) delays in progress toward Goverament's liberalization of input supply and marketing, or in the pace of implementing the financial reforms as agreed under the Financial Secor and Enterprises Development Project, which could discourage new investments; and 4iii) delays in implementIg the restructuing of vital rural institutons. Theso risks are considered to be minimal because the Project is designed to overcome these risks and required up-front actions. The prospet for achieving the Project's objectives are very good. 21. Remmedation. I am satisfied that the proposed Credit complies with the Articles of Agreemen of the Association and recommend that the Executive Directors approve the proposed Credit. Lewis T. Preston President At_achmts Washington, D.C. May 4, 1993  -7- Schedule A MALAWI RURAL FINANCIAL SERVICIES ]PROJECT Estimated Projec Costs and Fanndng Plan EsUzated Pject Costs Local Foreg TOa al Foreg TotaW _-m 000- -US$ 000 A. INVESTMENT COSrS 1. Good& (mael/VcbhJi ) 0.0 25143.3 25143.3 0.0 6285.8 6285.8 2. Taining 2039.8 226.6 2266.5 510.0 56.7 566.6 3. Technkd Asitante 0.0 7820.0 7820.0 0.0 1955.0 1955.0 4. Line of CrIt 72000.0 8000.0 80000.0 18000.0 2000.0 20000.0 TOTAL INVESTMENT COSTS 74039.8 41189.9 115229.8 18510.0 10297.5 28807.4 B. RECURRENT COMSTS 1. SalieBs 13754.8 0.0 13754.8 3438.7 0.0 3438.7 2. OCher Opoeding Cost 3994.4 9320.2 13314.5 998.6 2330.0 3328.6 TOTAL RECURRENT COSTS 17749.2 9320.2 27069.3 44373 2330.0 6767.3 TOTAL BASELINE COSTS 91789.0 S0510.1 142299.1 22947.3 12627.5 35574.8 Physica CoAingWemisc 0.0 1257.2 12S7.2 0.0 314.3 314.3 rice Continge,es 2451.7 821.5 3273.2 612.9 205.4 8183 TOTAL PROJECTr COSS 94240.7 52588.8 146829.5 23560.2 13147.2 36707.4 Project Financing Plan Llocl ForigD Total - U milon IDA 11.9. 13.1 25.0 Governmet 4.0 - 4.0 MRFC 4.7 4.7 Sub-borrowers 3.0 - 3.0 Total 23.6 13.1 36.7  -8- Schedule B Page I of 3 MALAWI RURAL FINANCIAL SERVICES PROJECT I bcruat MSethiod and Dlslwr_ena Procurement Method Category lCB LCB Others NA Totl -_ US$ million Goods 4.5 - 2.0 - 6.5 1DA (4.5) - (0.5) - (5.0) Technical assistance - - 2.0 - 2.0 1DA - - (2.0) - (2.0) Studies and training - - 0.8 - 0.8 1DA - (0.5) - (0.5) Opweating cost of MRFC - - - 7.4 7.4 11DA - (0.5) (0-5) Line of credit - 20.0 - 20.0 11DA -- (17.0) - (17.0) Total 4.5 - 24.8 7.4 36.7 IDA (4.5) - (20.0) (0.5) (5.0)  -9- Schedule B Page 2 of 3 MALAWI RURAL FINANCIAL SERVICES PROJECT Disbursent Amount and 1 te for IDA Credit C ry Amount of Credit Percentage Finmced by IDA ((USt$ Milion) 1. Line of Credit 17.0 100 percent of foreig exeditures and 90 percent of local epeditures. 2. E _upment and Vehicles 4.8 100 percet of foreign expenditures and 80 percent of previously impord goods. 3. Technica Assistac 1.7 100 percet of total expenditue. 4. Studies and Traning 0.5 100 percent of total S. nCeme Oeating Costs 0.5 90 pernt of total 6. PPF 0.5  - 10- Schedule B Page 3 of 3 MAIAWI RURAL FINANCIAL SERVICES PROJECT E simated Schedule of Disbursent Estmated 11DA Disbursement S&hedule (US$ million) .Projet year FY94 FY95 FY9 FY97 Annual disbursaemens 6.9 8.3 8.5 1.3 Cumulative disbursements 6.9 15.2 23.7 25.0  Schedule C MALAWI RURAL F